Commentary

France, Germany both right in euro disagreement

Analysis: Currency too strong for Paris, not strong enough for Berlin

StephenFidler

French President Francois Hollande at a February news conference at the European Parliament.

BRUSSELS (MarketWatch) — France and Germany disagree about the euro.

Reuters

A machine counts and sorts out euro notes at the Belgian Central Bank in Brussels.

French President Franois Hollande said this week the common currency is overvalued and argues that its valuation can’t be allowed to hang “on the mood of the markets.” Germany responded by announcing that the euro isn’t overpriced.

They are both right. From Berlin’s vantage point, the euro is, if anything, cheap. At its current level, Germany’s export industries are doing very nicely. For France, it is anything but.

Calculations by analysts at Morgan Stanley, published this week, put the fair value of the euro for Germany, if it were standing alone, at $1.53. For France, it is $1.23. The euro is significantly undervalued for the German economy and overvalued for the French.

France’s dilemma is described in a November report on competitiveness to the French government by Louis Gallois, the former chief executive officer of EADS
EADSY, +0.39%
Bottom line: Unlike their counterparts across the Rhine, French industrial companies have ended up in the wrong segment of global product markets.

French industry finds itself “caught in the middle,” Gallois said.

German industry is protected by being positioned at the premium end of most of its markets, where there is less price sensitivity, and by the country’s success over the past decade in reducing costs.

From the other side, French exporters are being assailed by lower-cost competitors.

French companies have, over the past decade, cut profit margins in a bid to stay in the game, but they’ve lost ground in the productivity stakes.

“French industry has not succeeded, with some exceptions (luxury goods, aeronautics, nuclear, pharmaceuticals, and some food products), to move upmarket,” Gallois concluded.

It isn’t only for France that the rising euro is painful. For other economies in Europe, particularly those on the struggling fringes, euro strength threatens to negate their efforts to make their economies more competitive.

“All the potential effort that these countries are doing painfully for internal devaluation — by cutting wages, keeping them below productivity growth and so on — can be undone by the strength of the euro,” economist Nouriel Roubini said last month in Davos.

The euro’s strength has followed what appears to be the receding threat of a euro-zone breakup, thanks to pledges from the European Central Bank to stop speculative runs on the region’s banks and governments. With aggressive easing by the central banks of the U.S., U.K. and Japan, the euro is left as the least ugly dog.

If you assume the worst is over, the bond markets of Spain and Italy offer a nice interest-rate pickup for investors over the alternatives. Morgan Stanley analysts say Japanese investors “have been leading the way in returning to European markets.” If the euro isn’t at the point of breakup, therefore, it seems to be condemned to be one of the world’s strongest currencies.

Kit Juckes, head of foreign-exchange research at Societe Generale, has said the euro has been supported by rising interest rates in the euro area — since ECB President Mario Draghi’s Jan. 10 news conference, two-year euro interest rates have risen by 0.25 point — and by the move into surplus of the bloc’s balance of payments.

With aggressive easing by the central banks of the U.S., U.K. and Japan, the euro is left as the least ugly dog.

Roubini said that if the ECB is worried about the euro’s strength undoing the good work of governments, it should act by following other major central banks in aggressive “quantitative easing” — purchasing assets to pump money into the euro-zone economy.

Draghi did throw the ugly dog a bone late this week. He pointed out that the exchange rate remained near its long-term average and made a statement of the obvious: that the level of the euro could affect both euro-zone inflation and growth. “The exchange rate is not a policy target, but it is important for growth and price stability,” he said. “We certainly want to see whether the appreciation is sustained.”

This possible hint that he will tackle euro appreciation if it goes too far was enough to push the euro lower. But whether he will follow these words with action remains to be seen.

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